Study: Clarification Needed on Swap Dealer CCO Annual Reports | Practical Law

Study: Clarification Needed on Swap Dealer CCO Annual Reports | Practical Law

A recent study suggests that further clarification is needed from the CFTC on requirements under CEA Section 4s for swap dealer chief compliance officers (CCOs), including requirements relating to CCO annual reports.

Study: Clarification Needed on Swap Dealer CCO Annual Reports

Practical Law Legal Update 3-582-9069 (Approx. 4 pages)

Study: Clarification Needed on Swap Dealer CCO Annual Reports

by Practical Law Finance
Published on 07 Oct 2014 • USA (National/Federal)
A recent study suggests that further clarification is needed from the CFTC on requirements under CEA Section 4s for swap dealer chief compliance officers (CCOs), including requirements relating to CCO annual reports.
Many final Dodd-Frank rules governing swap dealers (SDs) have now been in effect for more than a year. Among these are CEA Section 4s(k) and CFTC Regulations 3.1 and 3.3, which require SDs to:
  • Employ a dedicated chief compliance officer (CCO), under CFTC Regulation 3.3(a).
  • File annual CCO reports, which SDs must submit to the CFTC, under CFTC Regulation 3.3(f).
A study recently published by the law firm Wilmer Hale suggests there are still lingering questions over the roles and responsibilities of CCOs, particularly for non-US SDs.
The review found that as of May 31, 2014, 105 entities were provisionally registered as SDs and are therefore subject to the CFTC's CCO rule, which became effective in December 2012. Of those, 53 are located in the US, with the rest in other jurisdictions, including the EU, Canada, Australia, Hong Kong, Japan, Mexico, Singapore and Switzerland.
Under final Title VII CFTC rules, the annual report functions as the medium by which the CCO of the SD must in effect attest to the CFTC that the firm is compliant with Dodd-Frank Title VII swaps rules through written communication. The annual report covers a wide range of compliance issues, including evidence of trading that would raise conflicts of interest and events that are deemed as non-compliant with rules governing swap trading. The CCO annual report must include details of SD Title VII compliance policies and procedures under Section 4s of the CEA (referred to as "Section 4s submissions") (CFTC Regulation 3.3(e); CEA section 4s(k)).
The CCO reports are reviewed by the CFTC and the National Futures Association (NFA), the self-regulatory association charged with implementing SD registration requirements and overseeing SD compliance with CFTC Title VII regulations. The CFTC and the NFA have found numerous requests for more detail in the reports, particularly regarding the procedures SDs are or will be using to implement their Title VII compliance policies.
However, for non-US SDs, the rules are somewhat more flexible. In December 2013, the CFTC issued several "comparability determinations" in accordance with the policies and procedures set out in the CFTC's Interpretive Guidance and Policy Statement regarding the cross-border application of the swap provisions of the Dodd-Frank Act and the CFTC's regulations (see Legal Update, CFTC Issues Dodd-Frank Substituted Compliance Determinations for Non-US Jurisdictions). According to the study, "The comparability determinations permit non-US swap dealers to comply with most of the CCO requirements of their home jurisdictions — including the annual reporting requirements of their home jurisdictions — rather than the requirements under the CCO Rule (i.e., 'substituted compliance')."
The study adds that both US and non-US SDs require that CCOs be "actively engaged in all aspects of swap dealer compliance, be provided with both the authority and resources to facilitate effective compliance, and have direct and meaningful access to the swap dealer’s governing body.... In conducting their reviews, the CFTC and the NFA have also recognized the complexities involved in the new swap dealer regulatory regime and have indicated a willingness to work with swap dealers to refine and improve their Section 4s submissions. NFA on-site examinations of US swap dealers were scheduled to begin in the summer of 2014."

Issues That Require Clarification

The following are issues on which SDs have sought greater clarity from the CFTC:
  • Definition of "material noncompliance." The annual report must identify "material noncompliance issues," a term the CFTC has declined to define. Thus, the CCO must use his or her judgment to determine when a noncompliance issue is material and must be reported. It remains to be seen how much flexibility the CFTC will allow in making a determination of materiality under this rule.
  • Conflicts of interest resolution. Similarly, the CCO is responsible, in consultation with the board of directors or senior officers, for "resolving any conflicts of interest that may arise" and for taking reasonable steps to ensure compliance with CFTC regulations. The CCO's authority in these areas is not precisely defined. The CFTC has explicitly declined to adopt the "existing precedent for compliance models in the financial services industry," but has not provided specific guidance on alternative models.
  • CCO dual roles. It also may be challenging for a CCO with a dual role (for example, an individual who is both CCO and general counsel), which is permitted under the CCO rule, to manage all aspects of both roles, some of which may potentially be in conflict. As the CFTC and NFA review Section 4s submissions and CCO annual reports over the next two years, they may provide additional guidance on this.
  • Non-US SDs. The CFTC's comparability determinations provide that a covered SD may follow only its home jurisdiction rules with respect to preparation and form of the annual report, and that the report be certified by the SD's CCO or CEO and timely submitted to the CFTC. However, different requirements and practices outside the US have raised a number of issues for non-US SDs regarding how to comply with the substituted compliance determinations. Concerns have ranged from issues of scope to issues of format and timing. For example, there has been significant uncertainty as to the degree to which non-US SDs should read the CFTC's comparability determinations literally and rely fully on substituted compliance, and whether they should provide to the CFTC precisely in form and substance that which they are required to produce in their home jurisdiction.
The study notes that the CFTC and the NFA have both responded to these issues by asking SDs for more detail, particularly on SD procedures.
The study concludes: "We would expect, at least for the coming year, to see an iterative process between the regulators and swap dealers as they work through the appropriate level of detail and the various interpretive and implementation issues, many of which will likely only be identified after a complete review of the Section 4s submissions and the CCO annual reports and on-site examinations by NFA."
For more details on these and other CFTC regulations applicable to swap dealers, under CEA Section 4s, see the NFA Section 4s page.
Material based on an article written by Henry Engler for the Compliance Complete service (http://accelus.thomsonreuters.com/products/accelus-compliance-complete) of Thomson Reuters Accelus. Wilmer Hale study originally published in The Review of Securities and Commodities Regulation.